Lawsuit By Defaulting Buyer Calls For Action By Seller On Earnest Money

June 07, 1992|By Robert Bruss.

Q-We signed a purchase contract to sell our home and the buyer made a $5,000 earnest money deposit, which is held in the real estate broker`s trust account. A professional inspector found the house to be in good condition, except for a few minor things, which we promptly repaired. But the buyer changed her mind and never applied for a mortgage. Now she is suing us for return of her $5,000.

Meanwhile, we put the house back on the market and after two months we received a purchase offer which, after negotiations, resulted in our selling for $4,200 less than the first sales contract. We feel entitled to keep the first buyer`s $5,000 deposit, but the realty broker refuses to give us the $5,000. What should we do?

A-Many misguided home buyers think they can get out of honoring their purchase contract by refusing to complete the sale. To make matters worse, when defaulting buyers sue the sellers for refunds of their earnest money, liberal judgesoften order the money returned because of the old legal maxim

``the law abhors a forfeiture.``

Since your buyer has sued for refund of the $5,000, you have no choice but to answer the complaint. However, you also have grounds for a cross-complaint for the $4,200 loss on the second sale of your home. For further details, consult a real estate attorney.

Q-We own two rural properties we inherited. Someday we might build a vacation or summer cabin on one of these parcels. Each is worth around $40,000. I have been thinking about that article you wrote last year about prescriptive easements and adverse possession. It occurred to me it would be easy for someone to use our properties without our knowing about it as we haven`t seen them for years. To prevent a person from gaining a prescritive easement or title by adverse possession, should we post a ``no trespass`` sign on the property?

A-Posting a no trespass sign on your land won`t stop someone from meeting the requirements of open, notorious and hostile use without your permission. In addition, acquiring title by adverse possession requires payment of the property taxes for the number of years required in the state where the land is located.

The best way to prevent a person from acquiring a prescriptive easement or title by adverse possession is to inspect your land every year or two to be certain nobody is using it without your permission. For further details, consult a real estate attorney in the state where your land is located.

Q-We plan to sell a commercial building we bought in 1954. Although the property has declined in value the last few years due to a changing neighborhood, we still will have a tremendous profit. After reading your installment sale article a few weeks ago and since we are not interested in a tax-deferred exchange, it occurred to me an installment sale is a good way to sell, so I can get some retirement income from the mortgage interest. But in 1985 we refinanced the property with a new mortgage and took out about $150,000 cash. How will this affect our tax situation?

A-You probably have an ``excess mortgage,`` because the balance exceeds your depreciated adjusted cost basis for the property.

To illustrate, suppose the building is worth $400,000 today, you paid $100,000 for it in 1954 and have depreciated its book value down to $40,000. When you sell, your profit will be $400,000 minus $40,000 or $360,000 in this example.

Presumably your mortgage exceeds your low book value basis, so the excess over basis becomes part of your taxable profit. However, by making an installment sale, you will spread out your profit tax. You also will be creating a wonderful investment for yourself on which, in today`s market, you earn you at least 9 percent annual interest. For further details, consult your tax adviser.

Q-When you give advice on Internal Revenue Code 1034, the ``rollover residence replacement rule,`` you say that to defer the profit tax, the replacement home must cost at least as much as the old home`s sales price. But can I deduct the sales commission, improvements, the $125,000 ``over 55 rule`` deduction and other sales costs of the old home? Also, when buying a retirement home, you say it is smart to get a big acquisition mortgage and conserve cash. But will mortgage lenders consider interest on that cash when qualifying for a retiree`s mortgage?

A-From the postmark on your letter I see you live in a very affluent area. I presume your home has appreciated substantially over the years. Suppose it sells for $300,000 after paying the realty sales commission and other selling costs. Subtracting your $125,000 ``over 55 rule`` exemption, leaves a $175,000 ``revised adjusted sales price.``

If you buy a replacement principal residence costing at least $175,000 in this example within 24 months of the sale, you can defer tax on any sale profit exceeding your $125,000 ``over 55 rule`` exemption. Any improvements you added to the house are irrelevant.

As for obtaining as large an acquisition mortgage as possible on your retirement home, mortgage lenders consider all your retirement income such as Social Security, pension, interest and dividends when qualifying for the loan. If you foolishly spend all the cash received from the sale of your old home on the purchase of your retirement home, then you may become property rich and cash poor. Should you need cash for an emergency, the only lenders who will then talk with you are the high interest-rate loan sharks.